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Piketty: A Diagnosis of the Present or a Guide to the Future?

Perhaps you’ve heard of Thomas Piketty, the French economist. Maybe you’ve even read his 696-page bestseller, “Capital in the Twenty-First Century.” Regardless, this is the book of the moment.

Much has already been written in praise of Piketty’s work. Ryan Avent dubs it “incredibly ambitious”; Martin Wolf calls it “enthralling.” Critics are slowing emerging too, most notably Chris Giles at the Financial Times, who finds numerous errors in the book’s inequality data—though none so egregious as to challenge the book’s central premise. And Larry Summers sunk his praise into a forceful critique of Piketty’s supposed “iron law of capitalism.” This book is clearly too important to be left alone.

“Capital” rests on years of research into growing concentrations of wealth and income around the world. Piketty finds that returns on capital invariably grow faster than labor income, thus driving inequality inexorably higher. There is no natural force in capitalism that reverses this trend. Only World Wars I and II kept inequality at bay, due to their immense capital destruction and higher taxes, followed by sustained periods of growth. Our future is one of affluence begetting affluence, with more wealth bringing even greater returns.

[pq]Piketty’s analysis may be one instance when history is not the best guide to tomorrow.[/pq]

Reading Piketty is really a matter of figuring out the changing connection between capital and labor today. Few are able to challenge his findings on growing wealth inequality today. Yet Piketty’s long-term argument ultimately rests on proving that capital and labor are no longer one-to-one complements. I’m tempted to agree with him—for now. Smart machines are starting to do the things that only humans could once do. Better technology and education are increasing returns to capital owners while keeping wages low (a trend reinforced by globalization). I happen to believe that these are both the central drivers of inequality today and our hope for opportunity tomorrow. Piketty acknowledges these forces, but believes they are distractions from his grand theory of capitalism—that it spurs wealth to grow faster than economic output.

Piketty is far too confident in this stable growth in the return on capital. For instance, he assumes that no political instability will intervene, and that nothing in the Information Revolution will change the relationship between capital and rents. In fact, I believe that returns to capital and labor are just as likely to cease diverging. Increasing returns to capital may draw wages up with it while improving living standards (an under-explored part of Piketty’s work), particularly as we find more ways for workers to better complement today’s smart machines. As long as labor continues to complement capital, and those with capital continue to compete with each other for workers, Piketty’s analysis will fall short.

It doesn’t help that Piketty seems slippery in how he uses the term capital. He says at the outset that capital is any asset—physical, intangible, or financial—that generates a monetary return. Yet at varying points in the book he seems to be confusing capital’s particulars for its whole. His focus will linger on physical capital and then shift to its financial variant—in most instances, he simply refers to each as capital. What’s obscured in the process is the starkly different form capital can take and indeed has taken throughout the centuries, particularly when they’re seen in Piketty’s frequent literary references. In other words, Jane Austen’s capital is different than Mark Zuckerberg’s. Piketty is ill-served by his lack of care in deploying the central term of his work.

Piketty’s book is best seen then as a study on wealth rather than capital. Put that way, it doesn’t seem too surprising to say that technological gains (which is different than saying capitalism itself) will encourage more wealth creation than ever before. Many others will stagnate. Zuckerberg’s billions will grow, while the average Joe’s earnings will increase at a much slower rate. New kinds of capital (intangible and human) may drive inequality for a short time. This is not too dissimilar a finding than what Tyler Cowen has been saying about the rise of smart machines ensuring that “average is over” for human labor. This sort of inequality is a feature of capitalism undergoing a period of great change, not an inherent bug to root out.

Yet Piketty’s work also begs a question: Can the growth in inequality also be explained as a factor of rent-seeking? That is, are we simply seeing evidence of people taking more of the pie through political means rather than working to make it bigger through the marketplace? Piketty shows how inequality grew significantly in the lead-up to WWI, then was disrupted by war, and is now becoming more established. The scope of the rentier state seems to match these ebbs and flows of capital, growing in weight during the Gilded Age and rising again with today’s advent of the global plutocrat. Since the turn of the century, developed and developing countries alike have been spinning out an ever-increasing share of billionaires from what The Economist dubbed “crony sectors.” This is an angle on inequality that’s worth exploring, particularly in combination with our insights on the impact of technological change. Rent-seeking is more likely to reinforce inequalities resulting from disruptive change, as current capital owners seek out all of the gains while pushing off the newcomers.

When it comes to policy solutions, I think it’s easy to support Piketty’s proposal of a global tax on wealth—that is, if you assume that the wealthy are like Scrooge McDuck, hoarding their billions in stagnant pools of gold. But I think it’s safe to say that capital is readily reinvested today, whether in new businesses or through philanthropy, and is subject to greater depreciation than Piketty’s analysis accounts for. Wealth is also easier to use for consumption today than in Jane Austen’s time, something that Piketty seems to miss. This means our priority should be less on confiscating wealth and more on ensuring it’s being allocated in a competitive marketplace.

Easing land-use regulations would also go a long way toward easing wealth inequalities. Restrictions on development in our largest cities are pushing real estate prices beyond the reach of many middle class buyers. The result is fewer newcomers amassing their own little pile of capital, and more wealth accumulation for incumbent homeowners. Earning potential is also kept down as individuals choose to live further away from denser, frequently more productive areas. While there is no assurance that freeing up land usage would directly channel more wealth to the middle class, we know for sure this would strike a blow to rent-seeking and improve the economic climate in the urban areas where more of us are living every day.

Ultimately, the danger we face with Piketty is in reading too far into today’s circumstances. A century removed from World War I’s devastation of capital, we have now regained those same heights of wealth. If we had looked at the future from 1910, perhaps we would see the same things that Piketty does. That would not be true a decade later. We risk making a similar error in seeing too much of the future in today’s turmoil.

Piketty particularly sees Belle Époque France of 1871 to 1914 as being the representative norm for the future. In other words, we are essentially reading a book on Europe’s past as being explanatory of America’s future. We want to be careful with this comparison of different eras and political economies. Piketty’s analysis may be one instance when history is not the best guide to tomorrow.

Our shaky sense of the future is compounded today by fruit of our living in a schizophrenic economy. In one sense, we’re riding the wave of a new industrial revolution. In another sense, we are barely removed from a massive recession. We can say the future will be like today insofar as today is known. I believe that Piketty’s work reveals an awful lot of our past, but we should be wary about reading too much of it into the future.

In the end, “Capital” says less about the twenty-first century than it does about today—and our fears of tomorrow.